Four Ideas

1) The government is exchanging preferred for common re: Citigroup, and mandating that no dividends be paid to preferreds. Through its actions, the governmentt has basically compelled the other preferreds of Citi to convert to common: If you're not going to get a dividend, you might as well at least get a vote by converting to common. Govt actions have made the preferreds of other companies worry that the same fate applies to them, and in so doing upended the whole preferred market, just as happened when the govt took over Fannie Mae. Another unintended consequence of govt meddling in private business. 2) Re: banks. Where are we? The government is backing away from doing something about toxic assets , instead moving again to capital injections. The govt won't nationalize or put the banks into receivership for fear of another Lehman-like effect on the market. But this course of action leads down the path of a Japanese style lost decade. There is no easy way out of the current predicament. 3) I cracked out by macro notes from my MBA studies, and my macro textbook, co-written by Bernanke no less. What determines investment? I f(-r, -t, Af). Investment is negatively affected by higher real interest rates, negatively affected by higher taxes on investment and positively affected by the future marginal product of capital , which itself is a function of productivity. In the long run the government's massive issuance of debt will likely raise interest rates. Unless the government can repeal the laws of economics, higher taxes and issuance of govt debt should hurt investment which will in turn hurt GDP, which will in turn hurt the stock market. 4) Re: taxes--The new administration wants to eliminate the tax shield that companies get from conducting business abroad. This is a big deal. Many of the companies I model have effective tax rates in the 25% range because of this tax shield. If you move from a 25% tax rate to a 35% tax rate, EBITDA (1-t) goes down by in excess of 10%. And incorporating this into my discounted cash flow (DCF) models, DCF price values are lessened by 20% in several cases I've looked at. There is a reason the market is falling. If 600 to 700 was a price target on the S&P before, 550 to 650 is a credible price target now, and that's assuming we have a depression with a small d and not a Depression with a big D.

Philip Frank, PhD
President and Portfolio Manager,
 Insight Asset Management LLC
e-mail: insight-asset@earthlink.net